The FINANCIAL — Standard & Poor’s Ratings Services has revised its price assumptions for Brent and West Texas Intermediate (WTI) crude oil as well as its Henry Hub Natural gas price assumption.
We updated the prices in accordance with the methodology set forth in “Methodology For Crude Oil And Natural Gas Price Assumptions For Corporates And Sovereigns,” published Nov. 19, 2013, on RatingsDirect. In addition, Standard & Poor’s has changed the natural gas liquids (NGL) price assumptions in its oil and natural gas recovery price deck, Standard & Poor’s said.
Why Are We Revising Our Oil And Gas Price Assumptions?
The gas price revision reflects our assessment of the continued shifting of gas production to lower cost, highly productive reserve basins such as the Marcellus and Utica shales. The change in the oil long-term price deck reflects a shifting in the future curve and our projection that marginal production costs will be lower. Over the next few weeks, we’ll review exploration and production (E&P) issuers under these new assumptions. The review will also take into account company-specific factors, including our other rating assumptions and issuers’ flexibility to adapt to lower prices, hedge positions, and liquidity.
Despite capital spending cuts in the 30% to 40% range by U.S. E&P companies, a decline in oil production has yet to materialize. New wells drilled in the fourth quarter of 2014 continue to come online and producers have shifted assets to their most productive and profitable wells. With production continuing to grow, storage capacity issues are beginning to plague the market. According to the U.S Energy Information Administration (EIA), working storage capacity at Cushing, Okla. reached an all-time high of 54.4 million barrels on March, 13 2015. Measurements at Cushing are pivotal because it serves as the delivery point for WTI crude and accounts for about 19% of all commercial crude oil storage in the U.S. With these factors in mind, and given the steep one-year production decline curve in U.S. shale drilling, we believe any significant decline in oil production will begin to become apparent in early 2016.
While our fundamental view of the industry over the next 12 to 24 months hasn’t changed since our last update, the decline in our price assumptions in 2017 represent the prospects of a more muted recovery. We believe that OPEC, particularly Saudi Arabia, remain committed to maintaining production quotas to preserve market share and aren’t likely to deviate from this position until a significant ebbing in production from U.S. shale players has been achieved and new supply-demand equilibrium established. Also, with U.S shale drillers’ ability to rapidly increase production should higher prices return, we believe a more gradual and prolonged recovery will clear the market of marginal producers and restore an equilibrium in the supply and demand balance.
We lowered our Henry Hub natural gas price assumptions. According to EIA data, natural gas storage inventory levels are about 53% above levels of a year ago despite frigid winter weather conditions in the Northeast. Dry natural gas production for the lower 48 states reached record levels this winter and has thus far averaged 72 billion cubic feet per day in March. Shale plays account for more than 50% of the total production with the strongest growth rates coming from the Appalachian Basin, namely the Marcellus and Utica plays.
The boom in the U.S. oil shale drilling in recent years has also produced gas as a by-product of liquids extraction. While we expect gas as a by-product of liquid extraction to slow due to the effects of laying down oil-directed rigs, this could be offset by production from the low cost Marcellus and Utica basins.
Revision To Recovery Price Assumptions
Standard & Poor’s has also revised its NGL price assumptions in its oil and natural gas recovery price deck. We use the recovery price deck to value hydrocarbon reserves for speculative-grade E&P companies in our recovery analyses. While these price assumptions are intended for valuation of reserves in North America, we could use them to value reserves in other geographies as well. Where warranted, we could introduce other commodity price assumptions for specific regions.
This change in the NGL price assumptions reflects our observation of significant variation and volatility in NGL price realizations experienced by companies in recent years compared with our prior recovery price deck NGL realization assumption of 55% of our crude oil prices (at the recovery price deck). The differences in NGL price realizations have resulted primarily from varying compositions of NGL components (ethane, propane, butane, isobutane and natural gasoline) across companies and regional demand-supply dynamics affecting realization rates for these commodities.
We’ll now apply NGL reserves realization as a percentage of oil prices, similar to historical realizations for the past year for the company (or as appropriate). We believe that the revised NGL assumptions will better estimate reserve values for companies with material NGL production. Our crude oil and natural gas recovery price deck assumptions remain unchanged.
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